Bachelor Essay, Autumn 2013
Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
Opportunities and threats – will China manage its third
transition?
1
Bachelor Essay, Autumn 2013
Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
Summary
Last three decades, China has experienced a stunning economic development, which has
transformed the whole county on various levels. Until now, China has followed investment
and export led growth and has become the world’s largest manufacturer. However, under the
veil of rapid growth, social and economic imbalances have emerged causing a number of
serious challenges facing China. Moreover, the China’s export and investment boom is
expected to fall due to declining marginal product of capital and less comparative advantages
pointing at rising wages and increasing prices on land. The theory of the Solow model and
other economists suggests increased innovation and consumption driven growth in order to
rebalance the economy and move up in the value production chain. However, domestic and
global challenges may cause a drag on economic growth and deter a modernization process of
the Chinese society. Many eyes are watching and a demographical change with an ageing
Chinese population imply a limited window of opportunity. Furthermore, Governance framed
by ignorance, passiveness and instability will give rise to social and political unrest. China is
a diverse, and separated country. There is no definite answer whether a modernization process
will succeed.
Key Words: China, Economic Development, Macroeconomics, Solow model
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Bachelor Essay, Autumn 2013
Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
Table of Content
1. Introduction
2. Background analysis – what has driven the growth during the past decades?
2.1 The republic of china
2.2 Economic reforms since 1978
2.3 Main reasons for the rapid development
2.4 Rapid growth as explained by the Solow model
3. The Socioeconomic development
3.1 Urbanization – increased but limited
3.2 New attitudes
3.3 New consumption patterns
3.4 Increasing inequality and political unrest
4. The broken economic model
4.1 High investment and low consumption
4.2 Resource intensive export and environmental depletion
4.3 Big manufacturing sector but small service sector
4.4 State owned enterprises vs. private sector
4.5 External imbalances
5. Rebalancing strategies
5.1 Strategy 1 – Domestic consumption
5.2 The new Chinese consumer
5.3 Can consumption engine sustainable growth in China?
5.4 Strategy 2 – Innovation
5.5 “From catching up to cutting edge” – Solow model explanation
5.6 What creates an innovative, creative society?
5.7 Can China build a technological frontier?
6. Supportive reforms
6.1 What is the role of policy?
6.2 The 12th Five-years plan
6.3 The Third Plenum
6.4 Comments about the reformation programs
7. Which are the main challenges of China?
7.1 Expected trends
7.2 “Smart Urbanization”
7.3 Economic slowdowns and middle-income trap
7.4 Social tensions
7.5 The role of the government
8. Conclusion
1.1 Introduction
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Bachelor Essay, Autumn 2013
Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
Since the economic reforms in 1978, China’s enormous transformation has yielded impressive
results. Last three decades, the country has experienced two transitions – from an
underdeveloped, rural society to an industrial powerhouse and from a planned economy to a
more market-based one. The growth has been stable 10% annually and the country has
managed to lift more than 500 million people out of poverty.1 Two of the most influential
reforms were the market liberalization and the “open door” policies, which released
the Chinese economy from the strict control of the Communist party (1949-1976). The new
reforms created a platform for foreign trade and investment, and China became increasingly
involved in the global economy. The western and capitalist influence developed the economy
and modernized major institutions, such as the education and the banking system.
Additionally it liberalized the traditional restricted attitudes among the Chinese population
and contributed to a huge socioeconomic shift in China. The living standards improved, the
urban population doubled and the widespread misery decreased in many parts. However,
throughout the decades, inequality and the gap between rural and urban areas have increased.
Still, an extensive share of the population suffers from poor opportunities, low income and
insufficient access to energy and healthcare. Moreover the economic development is slowing
down and previous growth factors, such as export, investment and total factor productivity
growth are declining. If China wants to experience a continuing development the country
must adopt a rebalanced growth strategy. At the Third Plenum in 2013, the Government
presented a reformation program, the extent of which is comparable to the economic
reformation in 1978. Hence, China is aiming for its third transition - from a middle-income to
a high-income society. Economists underline domestic consumption, innovation and more
qualitative export, as the new engines of the modernization process of China. Yet, global and
domestic trends constitute a threat to the future sustainable growth. Moreover, China’s strong
global position implies an increasing pressure from international actors and, domestically, the
growing middle class demand reliable governance and an influential voice in the Chinese
society. To meet the economic, social, and global challenges of China, an open-minded and
determinant will of the Government is required. Many eyes are watching, and ignorance and
intransparency will unlikely generate success. Is China mature to face its third transition?
1
”China 2030 Building a modern, harmonious, and creative society” Worldbank report, Final edition 2013, Executive summery
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Bachelor Essay, Autumn 2013
Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
2. Background analysis – what has driven the fast economic growth during the past
decades?
2.1 The Republic of China from 1911-1976
Since the establishment of the Republic of China in 1911, the country has been experiencing a
bewildering modernization process. During the first half of the 20th century the economic
development was framed by improving conditions for agriculture, handicraft and foreign
trade. The society was developing at a rapid speed, with new factories, financial institutions
and improved infrastructure. However, political instability and widespread poverty prevented
the economic growth.2 In 1921, The Chinese Communist Party was founded in Shanghai to
fill the lack of strong leadership and political status. The successful revolution in the Soviet
Union became a source of inspiration. After the Second World War and the Chinese Civil war
in 1949, Chairman Mao and his communist party gained power in China. People were open
for a change and the organizational skills of the Communist ideology managed to steer
masses. Later, the regime became more totalitarian – individual freedom was limited and
executions and other harsh methods become common to control the people. In 1958, Mao
introduced the Great Leap, which involved efforts to increase the production and improve the
economy of China. He converted almost all farmers into communes and forced farmers to
work in teams and eat together in mass halls. Additionally rural households were encouraged
to build furnaces and produce steel and iron in their backyards. As bad weather hit China in
1964, around 25 million people died of famine. The economic transformation ended in a
disaster, which underlined the fact that economic and political objectives could not be
achieved by the same methods.
After the Great Leap, China implemented a new economic approach lead by Zhou Enlai.
The objective was to modernize China in four areas – industry, agriculture, defence and
science and technology. However the Cultural Revolution interrupted this process in 1966.
Mao wanted to regain his political power and defeat the old cultural tradition and the new
capitalist ideas by a social revolution. He organized Chinese youth into the Red Guard to
attack the economic planners and invade homes to threaten intellectuals and destroy literature.
Further, nearly 18 million youths were forced to move out to the countryside and universities
were closed. China was a suffering country with growing economic losses.
2
C. Chow, Gregory. “China’s Economic Transformation”. Blackwell Publishers, Massachussets, 2002 (s. 16-18)
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Bachelor Essay, Autumn 2013
Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
2.2 Economic reforms since 1978
After the death of Mao in 1976, Deng Xiaoping took over the control of the communist Party.
He managed to implement a wide range of reforms inspired by the economic approach before
the Cultural Revolution. According to Chow, the economic transformation was possible due
to four major factors. Firstly, the widespread dissatisfaction after the Cultural Revolution
created high incentives for the new Government to distance itself to the old regime. Secondly,
black holes in previous economic planning clearly called for an economic reformation.
Thirdly, the successful cases of implementation of market economies in Taiwan, Hong Kong,
Singapore and South Korea (the Four Tigers), were inspiring. Finally, the Chinese population
was discontent, suffering from miserable conditions and open for an economic reform.
Combined, these factors created a good starting point for a comprehensive reformation.
Unlike the strict control of the communist party of Mao, the new leadership loosened the reins
and implemented market-orientated reforms. The new major objectives were political and
social stability, economic productivity and public and consumer welfare. 3 The population was
encouraged to start up industries and private companies, which lead to a growing service
sector, higher productivity and increased personal income. The country went from a planned
to a more market-orientated market, and became more involved in the global economy.4
According to the Chinese American economist Gregory C. Chow, the economic development
of the last three decades could be explored in five major components – agriculture, state
enterprises, the private sector, institutional infrastructure and open-door policy.
(1) Agricultural sector
Between 1978 and 1979, some major reforms hit the agriculture sector. To increase the
incentives of hard work, the Government abolished the commune system, in which farm
workers did not own any land and were not rewarded for their labour. They liberated the rural
markets and implemented “The household production responsibility” system, which allowed
farmers to be responsible for a piece of land as long as the rent was delivered as a given
quantity of a specified product. The right to use the land was definite and transferable, thus
similar to private ownership except for the fact that it did not include the legal right to sell.
“The household production responsibility” system led to a rapid increase in output and
income for the farmers and still exists today. 5 However, the unclear ownership structure and
C. Chow, Gregory. “China’s Economic Transformation”. Blackwell Publishers, Massachussets, 2002 s. 46-47
Ibid s. 61
5
Ibid s. 48
3
4
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Bachelor Essay, Autumn 2013
Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
inadequate legal documentation have decreased incentives for urbanization, as the selling of
the land has benefitted the local governments but discriminated the rural households.
(2) State-own enterprises
The economic reformation affected the state-own enterprises sector during the 1980’s. The
reformation process started by discussing four major elements:

Independence regarding profits, production planning, sales of output and capital
investment

Implementation of an “economic responsibility system”

Increasing the role of the market

Encouragement of collectively owned enterprises
These reforms required a modernized market economy with decreasing price control and
restructuring of the state-own companies into modernized cooperations, which proved to be
comprehensive given the institutional and ideological tradition of the Communist party.
However, one major reform was implemented, the “contract responsibility system”, which
allowed enterprises to distribute the overshooting profit without restraints, as long as they
paid an obliged annual tax. However, the distribution of bonuses to managers was limited by
a social control, which decreased the incentives to take risks and profit-maximize.6
Overall, the state owned enterprises sector has remained relatively unchanged and is one
of the sectors in need of an extensive restructuring process in today’s China. Last years,
economists have called for a necessary decrease of the number of state-owned enterprises in
China, as they have proved to have inefficient resource allocation, overproduction and less
innovative competence.7
(3) Non-state sector
In the Non-state sector, the economic reformation contributed to a rapid expansion in
collective and private sectors in both the urban and rural regions. In the urban areas, many
state-owned stores and factories were converted into commercial and industrial companies,
and in the rural regions the growing number of private enterprises reached increasing support
by the local governments. The new reform of the agriculture sector generated the opportunity
6
7
C. Chow, Gregory. “China’s Economic Transformation”. Blackwell Publishers, Massachussets, 2002 s. 51
Intervju Kristina Sandclef, Macroeconomist East Capital
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Bachelor Essay, Autumn 2013
Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
to make a profit out of increased income, which spawned incentives to work hard among the
rural workers. But still, a lack of a modern legal system and limited help by governmentcontrolled resources held down the expansion of the private sector. The ownership rights of
the enterprises were confusing and the access to loans from financial institutions limited.8
Today the private sector consists of 5.5 million private companies with more than $1.3
trillion of registered capital employing close to 120 million workers. In 2004, the private
enterprises finally received legal protection strengthening their position against the
government-owned firms and in 2007 China’s first property rights law was implemented.
Much indicates that the current Government wants to improve the conditions further in the
future. 9
(4) Institutional infrastructure – Education and Banking-system
After the Cultural Revolution, the institutional infrastructure, including education and the
financial system improved in harmony with the developing society. Universities were
reopened and the range of opportunities for Chinese students increased rapidly. Earlier
banned intellectuals were raised to previous status and people were eager to absorb the new
ideas. Between 1985-1998, the Chinese education system established a cooperation program
with foreign education institutions and foreign scholars were encouraged to hold lectures in
the Chinese schools. The new opportunity to learn about the outside world improved the
language skills and many Chinese students were enthusiastic to study abroad. In the late
1990’s, the educational system was flourishing showing great results and higher motivation
among the students.10
Another institution that also improved gradually was the banking system. Before 1980, the
People’s bank was the only bank in China and controlled by the Government. It issued the
public financials and provided bank loans to state enterprises. 11 In early 1980s, the
government permitted four state owned specialized banks to accept deposits and conduct
banking business. These four institutes was: Industrial and Commercial Bank of China, China
Construction Bank, Bank of China and Agricultural Bank of China. The four specialized
banks are mainly owned by the government. In 1994, three more banks were implemented to
provide lending for specific objectives – The agricultural development Bank of China, the
China Development Bank and the Export-Import Bank of China. Along with the development
8
C. Chow, Gregory. “China’s Economic Transformation”. Blackwell Publishers, Massachussets, 2002 s. 53-54
9
Nee, Viktor & Opper, Sonja ”Capitalism from Below”. Harvard University Press, 2012, summery
C. Chow, Gregory. “China’s Economic Transformation”. Blackwell Publishers, Massachussets, 2002 s. 54-55
11
Ibin 52-53
10
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Bachelor Essay, Autumn 2013
Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
of the banking sector China has also allowed the establishment of a dozen commercial
banking institutions and a big number of city commercial banks.12 Two major laws have been
important for the bank system development – the law on the people’s bank of China and the
Commercial Banking law. Indeed, they mostly provide a basic framework for the idea of the
banking system and most of the practice does not follow the laws to the letter.13
Today, many economists have highlighted the need of a financial reformation in China.
As McKinsey mentions in their report about banking insights in China: “Chinese banks still
lend too much of their money to underproductive state-owned enterprises (SOEs) – a problem
that leaves them particularly vulnerable to changes in the economic climate and hinders the
country from achieving its stated regulatory goals/…/Nevertheless, China's enormous
economic progress over the past 25 years offers the hope that a similar transformation of its
financial system is also on the way.”14
(5) Open-door policy
Along with the new capitalist aspects, China opened up for foreign investments. Deng
emphasised the importance of advanced western technology and managerial expertise to
permit a “catch up”-process with the western countries. By introduction of the open-up
policies, the foreign investments were only accepted in four special economic zones in
southern China. The surplus of labour kept the workers wages at moderate levels in
international comparison. This accelerated the foreign direct investment and led to a
technological frontier and an improved internal economic system.15 In early 1980s, China
expanded the special economic zones to 14 coastal cities and three coastal regions and
reduced foreign taxes to attract more capital and business. The global influences grew during
two decades and led to an accession into the World Trade Organization (WTO) in 2001.16
Last three decades, the liberalization and globalization of the closed business
environment have contributed to a major part of the rapid growth. Exports and foreign
investments have brought in large dividends. As observed by the graph the foreign investment
increased from an annual amount of less than USD 1 billion to nearly USD 30 billion during
two decades.17 Today the Chinese socialist economy is the largest exporter and manufacturing
country in the world. Moreover it is the world’s second biggest economy by nominal GDP
12
Fox, Eric. ”Introduction to the Chinese Banking system”. Investopedia, 08-04-2011
C. Chow, Gregory. “China’s Economic Transformation”. Blackwell Publishers, Massachussets, 2002 (s. 52-53)
14
Article Mc Kinsey Insights ”The promise and perils of China’s banking system” (2006) Diana Farrell, Susan Lund, and Fabrice Morin
15
Dorrucci, Ettore Pula, Gabor & Santábara, Daniel. ”China’s economic growth and rebalancing”. ECB, Report 2013 s. 10
16
Shangquan, Gao “New Progress in China's Special Economic Zones” Foreign Languages Press, 1997
17
C. Chow, Gregory. “China’s Economic Transformation”. Blackwell Publishers, Massachussets, 2002, s. 53
13
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Bachelor Essay, Autumn 2013
Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
and PPP as well as one of the fastest growing economies with three decades of a growth rate
averaging 10%.18
2.3 Main reasons for the rapid development
According to Gregory C. Chow there are five major conditions, which allowed the success of
the revolutionary reforms: Firstly, the Chinese leaders were pragmatic and not constrained by
ideological restraints. The major objective was economic growth and as Deng Xiapiong once
said – “one should not care weather a cat is black or white as long as it catches mice”. The
pragmatism made the Chinese government open minded and willing to adopt new strategies.
They discussed a wide range of proposals and as one of the top officials said – “there is
nothing with value in the capitalist economy system that we cannot consider to adopt for
China”.19 Secondly, the Chinese government implemented plans through experimentation.
The leader Deng explained the strategy as “seeking truth from facts” and it was proved to be
very successful in two ways: it gave a clear result, which was necessary as the country lacked
a predetermined blueprint, and generated hard facts that made it easier to convince the other
members. The restricted ideology was less likely to prevent the reforms if they were
experimentally proved to work well. The process has been named “gradualism” because of
the step by step reformation, instead of a “shock therapy”, which involves reforms with
immediate impact.20 Thirdly, as the previous attempts for economic development had failed,
the Chinese population and the government were desperate for a new system. Fourthly, the
political stability permitted the Government to focus on economic growth, without
18
Eklund, Klas. ”Den nygamla supermakten”. SNS Förlag, 2011, s.184
C. Chow, Gregory. “China’s Economic Transformation”. Blackwell Publishers, Massachussets, 2002, s. 59
20
Ibid
19
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Bachelor Essay, Autumn 2013
Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
disturbances such as revolutions, wars and political instability. After the death of Mao, the
communist party maintained a stable and active role throughout the whole economic process.
Fifthly, an important factor was the fearless approach of Deng and his ability to convince the
other high-level members of the party. There was resistance from many parts and today
economists doubt whether there would have been an economic transformation of such extent
without a strong leader in the front edge. 21
2.4 Rapid growth as explained by the Solow-model
During the 1950s and 1960s China’s economy was a disaster with mass starvation and
widespread poverty. Since the death of Chairman Mao Chinese government liberalized the
market and imported advanced technology from abroad. In the beginning, the amount of
capital was small, which implied a high marginal product of capital. Combined with the new
reforms and open door –policies explained above, the investment and export rate increased
dramatically. In addition the better institutions stimulated the productivity in agriculture
leading to a surplus of rural labour that augmented the migration to Chinese cities. Farmers
went from living on subsistence level, to becoming urban workers contributing to an output of
a few thousands dollars. How can the Solow model explain this development?
The Solow model has its standpoint in a simple production function: Y = F (A,K,L),
which expresses a relationship between output and the factors producing it. 22
Y= output,
F= function
A = Ideas
K = Capital
L = Labour
Assume that A and L are constant, hence production function is: Y = F(K). By this
assumption an increase in K always implies an increase in the amount of capital per worker
(K/L) and an increase in Y always imply an increase in output per worker (Y/L). This means
that the growth in production output is depending on the increase in capital.
Furthermore, the Solow model is based upon a principle called the “Iron logic”, which
explains that the output increases at a diminishing rate. In other words, the first unit of capital
will be installed where it generates the most production. Thereby the second unit is slightly
21
22
C. Chow, Gregory. “China’s Economic Transformation”. Blackwell Publishers, Massachussets, 2002 s. 59
Cowen, Tyler & Tabarrok, Alex. ”Modern principles: Macroeconomics”. Worth Publichers, New York, 2010, ch. 7
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Bachelor Essay, Autumn 2013
Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
less productive than the first one, but more productive than the third unit and so on. Hence, as
more and more capital is added, there is a diminishing increase in output.23
Solow assumes that capital is the part of the output, which is saved and invested (K =
sY, where s = saving ratio). Also, the capital is depreciating over time, with a depreciation
ratio written as delta (d). When investment is greater than the amount capital depreciating
(sY>dK) the capital stock grows and will bring a larger capital stock and output in the future.
But when investment is less than depreciation (sY<dK), the capital stock is shrinking. The
central point is when investment equals depreciation (sY = dK), which is called the “steady
state of capital”. At this level, there is no further economic growth as every unit of new
investment has been used to replace the depreciated capital. Hence, in the long-run economic
growth due to capital accumulation will cease growing due to the diminishing returns.
24
To summarize, Solow explains that a greater investment rate means more capital and more
output. A country could experience a rapid economic growth by increasing the investment
ratio and thereby its steady state level of GDP. This has been the case in China, which by
increasing capital accumulation has reached a stunning economic growth last three decades. 25
23
Cowen, Tyler & Tabarrok, Alex. ”Modern principles: Macroeconomics”. Worth Publichers, New York, 2010 ch. 7 (115-123)
Ibid (Figure 7.4)
25
Ibid (115-123)
24
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Bachelor Essay, Autumn 2013
Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
3. The Socioeconomic development
As the economic growth took off in 1978, the socioeconomic environment changed
drastically. The improving institutions and “open-door” policies led to new social classes and
changed attitudes among the Chinese population. The high poverty ratio (at 80% in 1981),
declined rapidly and the urbanization increased.26 In the growing cities millions of Chinese
benefitted from the increasing opportunities regarding job, shopping and education. The new
generation grew up during an economic boom and was affected by the increasing interactions
with the western society. This changed the traditional attitudes towards concepts like
materialism and individualism affected the way of living in the Chinese cities. 27
Nevertheless the flourishing economy only benefitted a share of the population. At the same
time as the living of standard improved, the inequality increased. This created a gap between
the rural and urban population leading to the diverse and separated society of today’s China.28
In order to understand how the Chinese society went from a poor country, framed by
collective values and limited individual freedom, to become a middle-income country with
increasing individual freedom it is essential to explore the socioeconomic development last
three decades.
3.1 Urbanization – increased but limited
Since 1950, the urbanization in China has increased steadily along with emerging cities and
Industrialisation efforts. After the economic reform, the migration rate accelerated as massive
fluxes of labour moved to the cities seeking new employment opportunities. According to the
Chinese National Bureau of Statistics, during the past 30 years the number of urban citizens in
China has more than doubled from around 20% to over 50%.29 One major factor that sped up
the urbanization growth during the 1980s was the agricultural responsibility system, which
allowed the surplus of agricultural workers to transfer from the rural sector to the urban
sector.30 However, the government has strictly controlled the rapid urbanization. In 1958 the
Communist Party implemented a family register system to control the movement of people
between urban and rural areas. Individuals were attached to a specific region and categorised
as “rural” or “urban” workers. If a worker wanted to move into the city he/she needed
Dorrucci, Ettore Pula, Gabor & Santábara, Daniel. ”China’s economic growth and rebalancing”. ECB, Report 2013 s. 11
Faure, Guy, Oliver & Fang, Tony ”Changing Chinese values: Keeping up with the paradoxes”. International Business Review, 2008
Eklund, Klas. ”Den nygamla supermakten”. SNS Förlag, 2011
29
Yang, Yishuan. ”China can boost consumption by moving children and elderly into the city”. Quartz, 09-10-2013
30
Yeh G.O., Anthony, Xu, Jiang & Liu, Kaizhi ”China's Post-Reform Urbanization: Retrospect, Policies and Trends”. 2011. s. 9
26
27
28
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Bachelor Essay, Autumn 2013
Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
permission through a bureaucratic application process, which was time consuming and often
lead to disappointing results. In early 1980s, rules were loosened allowing people to work
outside their authorized geographical area without permissions. However, then they had to
provide their own livelihood and were denied access to social welfare, housing, health care,
education and so on.31 This system is called the hukou-system, and has caused misery and
humiliation among millions of “unaccepted” urban workers. It has been nicknamed the
“Chinese apartheid” and has caused social unrest and distortions in the Chinese cities. One
consequence is the current imbalance among the urban populations meaning the
underrepresentation of the young and older people, and an overrepresentation of the middleage group from 20-39. This is due to the fact that previous rural workers don’t dare bringing
children and elderly into the cities because of the risk of being denied public services.32 A
second consequence is that 200 millions migrant workers in today’s China are not allowed to
become legal residents. Among this group of people, the government faces a growing social
unrest due to discriminating rules regarding access to a social safe net, healthcare, education
and housing. 33
Another factor that has limited and still limits the urbanization is the blurry land
ownership rights of rural private households. The privatization of the rural households during
1980s transferred the ownership of farmland to households. However the ownership was
mutually attached to a village collective and due to lack of documentation and imprecise land
certificates the farmers have no ability to cash in the value of land rights today. The local
31
Luard, Tim. ”China rethinks peasant 'apartheid'”. BBC News. 10-11-2005
32
Yang, Yishuan. ”China can boost consumption by moving children and elderly into the city”. Quartz, 09-10-2013
33
Yao, Kevin.”China's cautious land-reform tests cast doubt on big urban vision” Reuters News, 10-11-2013
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Bachelor Essay, Autumn 2013
Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
governments reach high revenues, while rural household do not receive sufficient
compensation, sometimes none at all. As the economist Tao Ran, at Renmin University
explained it: “It’s not an ideological problem but a problem of interests. Local governments
still want to monopolise land sales and repay their debt.”34
The phenomenon of inefficient land sales has lead to slowing urbanisation and
inefficient labour mobility. Fewer rural workers dare to migrate, and among those who do,
most keep their farmland looked after by family or relatives, as a security.35 However until
they cut all the ties with their rural background, the hukou-system makes it impossible to
register as an urban resident. Improved urbanization is one of the major challenges facing
China. An improved access to social welfare, abolishing of the hukou-system and enough
compensation of selling farmland, are some of many factors, which would facilitate migration
and decrease the discrimination of the suffering rural population.36
3.2 New attitudes
In the urban regions the flourishing economy has brought an increasing number of global
interactions. Due to internationalized education, global trade and improving means of
communication the traditional culture of China, shaped by individualism and moral restraints,
has become increasingly challenged by western attitudes. Historically, thrift was one of the
central values of Chinese culture and stands for modesty and self-restraint. Chinese were
taught to have a restrained relation to materialism and a central precept was: ”when the
fortune comes, do not take too much advantage of it”. However, as the standard of living
improved, new attitudes emerged among the Chinese population. Combined with western
influences and better access to consumer markets in the urban cities, it increased the material
appetite of the growing middle class and changed the consumption patterns in many parts of
the country. 37
Another shifting concept was “individualism”. In the past group orientation was a
fundamental thinking in traditional China. Pleasure seeking for the own individual benefit
was considered immoral and the population was taught to value the society over the
individual. However, as the society became more market-based and liberalized, it allowed
new dreams among the growing number Chinese graduates. Many aspired for a successful
career and improved living standards and thereof the concept “individualism” naturally
Yao, Kevin.”China's cautious land-reform tests cast doubt on big urban vision” Reuters News, 10-11-2013
Yeh G.O., Anthony, Xu, Jiang & Liu, Kaizhi ”China's Post-Reform Urbanization: Retrospect, Policies and Trends”. 2011
36
Yao, Kevin.”China's cautious land-reform tests cast doubt on big urban vision” Reuters News, 10-11-2013
37
Faure, Guy, Oliver & Fang, Tony ”Changing Chinese values: Keeping up with the paradoxes”. International Business Review, 2008
34
35
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Bachelor Essay, Autumn 2013
Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
became more accepted. In addition, as the historical strict control of the younger generation
loosened, the call for an identity and the personal expression of feelings and opinions
thrived.38 The Tiananmen Square protest in 1989 is one occurrence reflecting the growing aim
of individual freedom as thousands of student gathered to protest for greater democracy and
less corruption among authorities. It received broad support from city residents but ended in
one of the major tragedies of Chinese modern history as a huge amount of students (around
3000) got killed.39
Today there is a gap concerning the attitudes of Chinese people – there are some groups
missing the old Maoism periods, his ability to gather China and develop a balanced society
framed by nationalism and traditional constraints, while others are becoming more
westernized in their way of appreciating life – striving for individual freedom and a higher
quality of life. The cultural development cannot be considered a shift from collectivism to
individualism, but this gap puts an increasing pressure on the Communist Party, which faces a
difficult challenge to control and keep together different interests in the country.
3.3 Consumption
Historically, behavioural and structural factors have restricted the consumption expenditure
among Chinese households. Since the economic development, the consumption has become
10 times bigger and experienced an annual growth averaging more than 7 per cent. This is
partly due to the transformation of the Chinese culture, which altered new attitudes towards
consumption and individualism, and partly due to structural reforms, which allowed
increasing expenditure among the Chinese population. One example is the “household
responsibility system” that allowed farmers in the rural regions to increase their income and
thereby their consumption propensity accordingly. The extra income was often spent on
housing and the construction of new houses, which was out of the government’s control.
During the 80s the rural housing conditions improved – from a per capita floor space of 8.1 in
1978 to a per capita floor space of 22.45 in 1997.40 Regarding the urban households, housing
was initially controlled by the state but as the economic reforms lead to more marketdetermined prices, it became a subject for demand and supply. This resulted in improved
urban housing conditions and between 1978 and 1998; the housing space per capita went from
3.6 to 9.3.41
Faure, Guy, Oliver & Fang, Tony ”Changing Chinese values: Keeping up with the paradoxes”. International Business Review, 2008
C. Chow, Gregory. “China’s Economic Transformation”. Blackwell Publishers, Massachussets, 2002 s. 61
40
Ibid s. 162
41
C. Chow, Gregory. “China’s Economic Transformation”. Blackwell Publishers, Massachussets, 2002 s. 163
38
39
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Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
The investment boom and rapid urbanization had a major effect on the consumption
pattern among the Chinese population. During the1980s, the high rates of investment
expanded the production capacity in the industrial and services sectors, which permit better
job opportunities in the urban regions. Migration increased and the demand for labour
intensive services grew among the wealthier households. This development has lead to a
sustained boom in Chinese household consumption.42
Last years prospects have called for accelerating consumption growth due to a growing
middle class, westernized attitudes and better access to consumer markets. However, the
Chinese households have the highest saving rate in the world and are known for consuming a
very small share of the total income. In fact, China’s
consumption power has since long been referred to as the
“caged tiger” and as observed in the graph below,
consumption has experienced a small growth in relation
to the GDP. In the future the politicians hope for a rising
consumption in order to stimulate the domestic demand
and generate a new economic growth engine. This puts a
pressure on the investment and urbanization approach of
Chinese central and local governments, as a larger
share of the population needs access to social
welfare, lending institutes and higher income jobs.
Eco nomic data proves that 1-point increase of the
urban population will cause a 1.2-point rise in
personal consumption expenditure.43 Currently,
China's urbanization rate is up to 53 per cent, from 39
per cent in the past decade, and prospects are
pointing at 65 per cent in the next decade. 44 To keep
the positive correlation between consumption and urbanization this development will require
a wide range of structural reforms and high investment, to prevent expansion of “mega slums”
and an increasing number of unregistered urban dwellers.45
3.4 Increasing inequality and political unrest
Australian Governmen. “The familiar pattern of Chinese Consumption growth”. Economic roundup issue 4, 2012
Sano, Junya. ”Key targets in the 12th Fiver-Year Plan and Policies for their Realization” Pacific Business and Industries, Vol. XI, 2011
44
Badkar, Mamta.”Everyone's Got The Chinese 'Ghost Towns' Story All Wrong”. Business Insider. 13-03-2013
45
Article, Australian Government (Economic roundup issue 4, 2012)”The familiar pattern of Chinese Consumption growth”
42
43
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Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
Even though many Chinese has reached an increased living standard the flourishing economy
has mainly benefitted a small part of the population. Since 1980s, the total national income
has increased more than 20 times while when calculated on per capita income basis the
development is only half as much (10.4).46 Another measure reflecting the high inequality is
the gini coefficient, which brings understanding of how far away the current income
distribution in a country is from becoming a total equal distribution. The higher gini
coefficient the greater income gap. As seen by the graph, the gini coefficient of China has
grown substantially. According to Klas Eklund, the number is above the average of European
countries, and slightly above the number of the U.S. Comparable to the more unequal
countries of Latin America and Middle East, the number is roughly at the same level. The
inequality in China is mainly an imbalance between the rural and urban regions and
observable in conditions regarding wages, job opportunities, health care and education.
During the 1990s, the middle-income was around twice as big in the urban areas as on the
countryside. Today, the richest regions on the coast have approximately a 10 times bigger
average income per capita and a 15 years older life expectancy, than the poorest inland
provinces.
Gini Coefficient
50
45
40
GINI
35
30
25
20
Source: Worldbank
Due to the superior focus on export- and investment driven economic growth, the rural
conditions have been less prioritized. The economic reforms managed to lift 672 millions out
of poverty but still there are hundreds of millions of people living on subsistence level in the
rural regions.47 The conditions are miserable: education is low, the social insurance virtually
absent, the access to water and electricity weak, and healthcare system mostly only provided
46
47
Eklund, Klas. ”Den nygamla supermakten”. SNS Förlag, 2011, s.184
World bank 2030
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Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
in the cities. The lack of well functioning infrastructure system in the rural regions has led to
poor access to consumer and financial markets and insufficient communication between rural
and urban regions. In spite of this social misery, the governmental welfare expenditure only
constitutes a few percentage of GDP. 48
The high inequality has caused social tensions and political unrest. The growing
unemployment has fuelled dissatisfaction and resulted in an increasing number of conflicts
and demonstrations outside cities. Combined with a slowing growth – the future of China
faces a socioeconomic threat.49 As the current president, Xi Jiping, became the president of
the people’s republic of China, he expressed a dream of China – to become a “moderately
well-off society” by about 2020 and a fully developed country by 2049. Indeed, China must
experience an economic and social transformation for the dream to come true.50
4. The broken economic model
Several conditions – domestic and external – that have contributed to the successful growth of
China, are now changing. Just as other emerging markets, China’s economy is expected to
cool off the coming two decades. GDP growth will decrease gradually from an average near
8.5 percent until 2015 to around 5 percent after 2026.51 Historical experience with other
developing countries suggest that investment-led growth usually end up in diminishing
marginal return on capital as countries grow richer and accumulate more capital per worker.52
As explained in by the Solow model in the previous section capital accumulation is not
sufficient to generate growth in the long run. This is due to the iron logic of diminishing
returns growth, which explains that eventually capital and output will cease growing and
result in a slowing growth in China.53
Hence, the total factor productivity has already peaked, causing a fall of economic
efficiency. Combined with other problems such as weak banking system, high inequality and
resource depletion, the economy calls for a change. In his speech in 2007, the premier
minister Wen Jiabao, emphasized that the growth is” instable, imbalanced and
48
49
50
51
52
53
Eklund, Klas. ”Den nygamla supermakten”. SNS Förlag, 2011, s.184
Ibid
Lawrence, Kuhn, Robert ”Xi Jinping’s Chinese Dream”, New York Times, 04-06-2013
World bank 2030
Dorrucci, Ettore Pula, Gabor & Santábara, Daniel. ”China’s economic growth and rebalancing”. ECB Report 2013, s. 37
Cowen, Tyler & Tabarrok, Alex. ”Modern principles: Macroeconomics”. Worth Publichers, New York, 2010
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Mentor: Zouheir El-Sahli
unsustainable”.54 In order to answer which new element that could drive long-run economic
growth, the major imbalances of the Chinese economy have to be explored further.
4.1 High investment and low consumption
One of the major imbalances of the Chinese economy is the abnormally high saving- and
investment ratios. The growth in investment ratio has varied between 30 and 40 % since
1980s, which is twice as large as investment ratios of other industrial counties.55 The industry
sector is enormous and the production cheap. From many perspectives, the high investment
ratio is positive, considering its contribution to a rapid economic development, job creation
and increased urbanization. However, the situation has two sides. As large investments permit
future production capacity and growth, it also decreases the private incomes and the purchase
power among the Chinese population. Today, the consumption growth relatively GDP is
among the lowest in the whole world, showing a negative development last two decades.
Between 1990 and 2011 (see graph) the private consumption share of GDP decreased from
half to one third, reaching historical lows (below 35%) in 2010, while the investment ratio
reached 45%. The global financial crisis increased the gap further, as high savings gave rise to
the investment trends.56
In order to modernise China, increased domestic consumption would is a necessary
development in order to long-term economic growth. Hence, the historical model must change
and create a better climate for savers to start spending their money.
4.2 Resource intensive export and environmental depletion
The fact that the growth is dependent on heavy industrial exports, implies high use of energy
54
55
56
Eklund, Klas. ”Den nygamla supermakten”. SNS Förlag, 2011, s. 181-182
Ibid s.184
Dorrucci, Ettore Pula, Gabor & Santábara, Daniel. ”China’s economic growth and rebalancing”. ECB Report 2013, s. 13
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Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
and natural resource depletion. This has caused an alarming environmental deficit and an
economy dependent on volatile commodity prices. Even though most individual industries
have decreased their energy intensity gradually, the combination of rapid growth and growing
urbanization has made China to the largest energy user in the world. According to Klas
Eklund, the fact that governmental banks have provided cheap loans to the State-owned
Enterprises has made the situation worse due to irresponsible and inefficient resource
allocation. 57
The natural depletion has lead to a decreasing ability to provide the inland population
with clear water, electricity and proper healthcare. As observed by the second graph, the
Chinese population has a low energy use per capital but the highest depletion of natural
resources in the world. Indeed, the increasing environmental pollution and carbon emissions
have caused domestic dissatisfaction and a serious global pressure. Unmet, this will cause
social unrest, global dissatisfaction and deter future sustainable growth in China.
China environmental depletion:
Source: Enerdata via world energy council
4.3 Big Manufacturing but small service sector
The high growth in industrial heavy manufacturing exports is also the main factor to the poor
development of the service sector, which has lead to an insufficient employment growth. This
is due to the fact that manufacturing companies mainly distribute their profits for further
investment. This has caused a growth too heavy on capital leading to a weak employment
growth, low wages and a passive consumption among the Chinese population.58 As the
economic model has emphasised capital- and less labour - intensive growth the manufacturing
sector has grown, while the service sector has become relatively small, resulting in an
alarmingly weak employment creation in China. As Timothy Beardson highlighted in his
57
58
Eklund, Klas. ”Den nygamla supermakten”. SNS Förlag, 2011, s.184
Ibin, s.182
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Mentor: Zouheir El-Sahli
book: “for 1 decade ago, 1 per cent of economic growth might have yielded I per cent
employment growth. But today 1 percent economic growth only produces 0.1 employment
growth”. 59
Graph source: CIA Fact book
Between 2001-2010, GDP was growing at 10% on annual average, while the employment
increased by less than 1%. This is a clear underperformance by international measures, and
along with the massive labour shift from the agricultural sector to urban cities it has lead to an
increasing unemployment. The excess of agricultural labour force has mainly been absorbed
by the services sector, which has contributed twice as many jobs as the manufacturing sector
since 1991 (around 150 million). Nevertheless, China’s weak service sector has a very low
working share by international comparison, pointing at barely 30% of total employees by the
end of 2010. This indicates a necessary output shift from the manufacturing to the service
sector in order to spur the employment growth in future China.60
4.4 State owned Enterprises vs. Private sector
Another alarming trend is the growing imbalance between the public and the private
sector. The government’s strong market influence always constituted the frame of the Chinese
“social market economy”. Currently, investment by state-owned enterprises (SOEs) is equal
to the investment by domestic private enterprises, and exceeds by far the investment by
foreign-owned enterprises. Last years, economists have underlined the fact that China’s
economy looks increasingly “commanded”, which is partly a result of the global crisis
2007/2008. The financial recession lead to an increasing control of central and local
government over the investments allocation, which was mainly financed through SOEs’
59
60
Beardson, Timothy. “Stumbling Giant – the threats to China’s future”. Yale University Press, 2013 s. 60
Dorrucci, Ettore Pula, Gabor & Santábara, Daniel. ”China’s economic growth and rebalancing”. ECB, Report 2013 s.14
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Mentor: Zouheir El-Sahli
loans.61 Additionally, the activity in the private sector decreased due to restricted access to
loans, in spite of a lending expansion in China. This was particularly a fact among the small
and medium enterprises.62
Many economists share the same view – in order to
modernize China and create a platform for
technologic development and innovation, the power
of the SOEs must decrease. Evidence show that the
simple access to bank loans and support by the
Government, have made SOE’s less competitive than
the private enterprises. In 2009, the return on equity
of nonstate firms was 9.9 percentage larger than of
SOEs, bearing in mind that large amounts of the SOE profits comes from a big monopolies,
which are profitable due to restricted competition. Furthermore, the financial sector is weak
and unable to meet the needs of a modern competitive economy. The lending activities are
discriminative towards households and private enterprises in spite of increasing financial
support for the SOEs and in the past, the Government has been forced to step in and save
banks due to irresponsible activities.63
Today, SOE’s dominate aviation, railways, steel, telecom, finance, energy, and
electricity.64 They benefit cheaper access to capital, land, and natural resources and has
contributed to the environment depletion, lack of innovation and poor employment creation.65
Moreover a restricted wealth distribution has lead to high savings rates and no dividens for
households and the central government. In fact, the government encourage the dividends to go
right back to the earnings of SOEs to invets in a future global competitiveness. However,
economists are questioning this state-led capitalism and according to Fred Hu, chairman of
financial advisory firm Primavera Capital Group “If this trend is not stopped, the future of
China’s vibrant, fast-growing, competitive economy is very much in doubt.”66
4.5 External imbalances
China’s high export and investment strategy has also created an external imbalance, as
measured by the current and capital account surpluses in the balance of payments. These two
Dorrucci, Ettore Pula, Gabor & Santábara, Daniel. ”China’s economic growth and rebalancing”. ECB, Report 2013 s.14
Ibid
63
The Economist. “China’s big banks, Giant reality-check”. 08-31-2013
64
Roberts, Dexter ”China's State Enterprises Have to Pay Up” Bloomberg BusinessWeak 05-17-2012
65
”China 2030 Building a modern, harmonious, and creative society” Worldbank report, Final edition 2013,
66
Roberts, Dexter ”China's State Enterprises Have to Pay Up” BloombergBusinessWeak (2012)
61
62
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surpluses accelerated along with the Asian financial crisis, with an outcome of record-high
exchange reserves in U.S. securities. Positively these reserves could provide financial support
during an economic slowdown caused by external shocks. But at the same time it also
increases the risk of large capital losses, in the appearance of a weakened dollar. Chinese
Government has met this risk by increasing its export of capital through outward foreign
direct investments in raw materials. This is also a way of securing the country’s need of raw
material supplies, but adversely it has given rise to suspicion and trade friction China’s global
relations. In other words, China must change the course of its rapid export driven growth in
order to decrease the current and capital account surpluses less aggressively.67
Currently China is facing an increasing global pressure – the two-side expanding trade
surpluses combined with lower volumes of import have fuelled the protectionist pressures.
Historically, the fierce protectionist increased against Japan, as its global market share peaked
in the mid- 1980s. Comparing China’s situation with the case of Japan, the Chinese growth is
expected to experience a twice as big peak with a global market share reaching 20% by 2030.
If China fails in rebalancing the economy to a less export-driven growth, increasing external
imbalances and growing trade frictions with its global relations implies a growing threat.
Moreover China’s export growth will slow due to the financial concerns and slowing growth
in the advanced countries, resulting decreasing global demand. 68
67
68
”China 2030 Building a modern, harmonious, and creative society” Worldbank report, Final edition 23-03-2013 s. 380-382
Ibid s. 6-8
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5. Rebalancing strategies
The Chinese dream of the present president XI is to become a “moderately well-off society”
by 2020 and a fully modernized high-income country by 2049. As stated by the imbalances in
previous section today’s situation is not sustainable but requires a rebalancing economic
strategy and serious efforts by the Chinese Government. According to Timothy Beardson, the
currents economic challenge includes two major questions:

How to build a more dynamic domestic economy?

And how to become a high-quality, more innovative, export economy?
5.1 Strategy 1 – Domestic consumption
Indeed, an increased domestic consumption could create a dynamic domestic economy. A
consumption driven growth would restore balance and stability on multiple fronts and
contribute to sustainability and a long-term growth. Firstly, the consumption trend is not as
dependent on the business cycle as the investment growth. Instead it depends on certain
fundamental factors such as access to markets, well functioning welfare systems and stable
incomes. If these conditions improved, the aspiration to build a modern, prosperous, and
respected country, would come closer.
Secondly, a consumption lead economy would require a shift to service sector and
consumption oriented industries. This would put less pressure on depleting natural resources,
which has been the result of the high production of energy intensive industries, and also lead
to increased job creation and decreasing unemployment. Hence – thirdly, social sustainability
would improve. As mentioned above, the economic growth has not been unevenly distributed
in China. The consumption led growth would lead to ‘more job creation per unit of
investment’ which combined with the increased social protection and decreasing income
inequality between the urban and rural regions, would protect the country against rising social
unrest. 69
Hence many factors are supporting a consumption driven growth. Since 2006, Chinese
authorities have highlighted the importance of a long-term mechanism to increase domestic
demand.70 But still, the Chinese consumption happens to be of the lowest share in the world
accounting for slightly more than a third of total output. Further, according to the latest
69
70
Maggu, Ankit”How should China transition to a Consumption driven economy?” CRISIL – Young Thought Leader (2012)
Australian Government “The familiar pattern of Chinese Consumption growth” Economic roundup issue 4, 2012
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Mentor: Zouheir El-Sahli
figures from the IMF the China’s personal savings rate has become the world’s highest;
currently at more than 50 per cent while the global average is of 20 per cent.71 Since decades,
the consumption power has been referred to as ”the caged tiger” as behavioural and structural
restrictions have deterred and still deter consumer spending. Nevertheless, the tiger is growing
fatter and fatter and many factors are supporting a consumption boom in the future. The
socioeconomic environment has changed and the living standard improved among millions of
Chinese. Accompanied by the westernized attitudes toward consumption and individualism,
the Chinese are expected to embrace a new shopping behaviour with increasing expenditure
in the future. Among the wealthier social classes and within the urban regions this is already
the case.
5.2 The new Chinese consumer
According to Boston consulting Group’s (BCG) report “The dynamics of China’s next
consumption engine”, the wealthier social classes will stand for a consumption boom over the
next decade. In fact, this is expected to make China the world’s second-largest consumer
market by 2020.72
Over the last decades, millions of Chinese have adopted a totally new consumption
pattern. In the modern cities, spending time in shopping malls, hypermarkets and department
stores has become an everyday-activity. Consumption as a modern phenomenon has
mobilized Chinese people and fuelled their material needs.73 There is one specific social class
that will contribute to the major part of the consumption growth in China – the affluent class.
Compared to the middle class, the affluent consumers are wealthier and have different
attitudes and objectives with their spending habits. Currently the affluent class is not as large
as the emerging and current middleclass combined, but the coming decade it is expected to
grow to 280 million. China is the only emerging market with a sizable affluent population.
Today it is estimated to 50 million as reported income, and accounts for 5 % of the global
consumption. (India; 7 million, Brazil; 26 million, and Russia; 10 million). As seen in the
table above, the upper and lower affluent class will stand for more than a third of the
consumption in China by 2020.
Article Business people ”China's savings rate world's highest”
Boston Consulting group ”The age of affluent is here” (2012)
73
Faure, Guy, Oliver & Fang, Tony ”Changing Chinese values: Keeping up with the paradoxes”. International Business Review, 2008
71
72
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According to an annual multicounty consumer research, China is the most
”consumption friendly” market globally. Future patterns of individual spending behaviour
shows that 37% of the Chinese consumers plan to increase their consumption in the future.74
The Boston Consulting group has interviewed 3000 affluent consumers to get a deeper
understanding for the consumption patterns in China. A clear observation was their aspiration
for emotional gratification. Their improved standard of living has created a new strive for
wellbeing, leisure and enjoyment and the Chinese urban life is framed by “enjoy life today”.75
The consumption is no longer in order to satisfy basic needs but for showing off and obtaining
identification. The affluent class spends money on pleasure as a sense of reward. In response
to their social class journey, they also want to express the higher social statues through
expensive items and luxury brands. As one of the interviewees said, “Luxury goods
symbolize the advances I have made in my career and social status”. Hence, luxury brands
work as indicators of success and social codes, and another interviewee stated: “Luxury goods
are a necessary tool for business”. However, the affluent consumer is not worry free, and still
prefer saving to spending. Many consider their purchases carefully in terms of “return on
investment” and believe that a good consumption morality generates good “returns” and is an
alternative way of persevering wealth and saving in bank deposits.76
The affluent class has a slightly more sophisticated and westernized attitude towards
consumption comparing to the middle-class consumers. They have greater exposure to outside
Boston Consulting group ”The age of affluent is here” (2012)
Faure, Guy, Oliver & Fang, Tony ”Changing Chinese values: Keeping up with the paradoxes”. International Business Review, 2008
76
Boston Consulting group ”The age of affluent is here” (2012)
74
75
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influences and the ability to support a more sophisticated lifestyle. They travel abroad and
inhale global trends and lifestyles. Companies that provide services such as “the newly
affluent table etiquette”, “how to order food” and “how to host dinner parties”, are becoming
more popular among the affluent spenders in order to learn about the good sophisticated life.
5.3 Can consumption engine sustainable growth of China?
To summarize, prospects for China point at a consumption boom and thereby a more dynamic
domestic economy. Trends suggest a decreasing labour force, which will raise the physical
and human capital stock per worker. Thereby the labour productivity will increase, driving up
the real wages and expanding the middle class and affluent class consumers. This will boost
the domestic consumption and increase the low share of consumption contribution to GDP
growth. Hence, the consumption growth is a natural process but not necessarily dynamic
enough to spur economic development. To reduce households’ savings and increase the
consumption, the Chinese Government must implement a wide pro-consumption program,
which spawns increasing private incomes, expansion of the service industries and better
access to social protection.77 Thus, a consumption driven growth is hit by many challenges.
Factors such as poor social security, underdeveloped financial opportunities, and
discriminating urbanization strategies have caused a drag on consumption growth throughout
history. Today, these factors still exist. In major cities, department stores are closing and
offices and luxury apartments remaining empty.78 In the rural regions the population has poor
access to consumer markets, unstable incomes and a deep-rooted cultural aversion towards
consumption. Hence, a pro-consumption program must be implemented soon to eliminate
structural and behavioural obstacles; otherwise the consumption growth will not be sufficient
to drive the modernization of China’s economy.
5.4 Strategy 2 – Innovation
To be able to compete on the global market China must increase the productivity and
innovation capacity among enterprises. The economy faces some hard facts – if it does not
manage to improve the production, the export will become less profitable due to three major
factors. Firstly, the increase of China’s global market share is limited. Currently, China’s has
a strong position in the key markets, which does not permit a further growth unless the export
77
Marianera, Manuela, ”Trends in Private consumption in China”. Confindustria 2010 s. 3
78
Världspolitikens dagsfrågar – Kina” The Swedish Institute of International Affairs, 2013 s. 62
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structure is improved. Secondly, a demographic change will deprive China of its major
comparative advantages – cheap and unskilled labor. Due to rising costs the Chinese
enterprises will be forced to introduce better ideas and more innovative production in order to
stay competitive. And, thirdly, global pressure pushes up the prices of resources. Thus, if the
labor productivity does not increase this implies declining marginal revenue in the energyand resource-intensive industries. To solve this solution Economists emphasize two major
measures – increased expenditure on research and development and commercialization of the
banking system. The latter is due to the fact that the current financial lending discrimination
benefits state-own enterprises but limits the growth of the small and medium sized
companies.79
5.5 “From catching up to cutting edge” – Solow model explanation
In order to generate a long-term growth the Solow model highlights the need of better ideas.
Better ideas permit more output from the same amount of input. This is crucial considering
the “Iron logic” of diminishing output of capital, which deters economic growth in the long
run. The development could be called: from “catching up” to “cutting edge”.80 Recall, the
simple function below:
Y = √K (labour is held constant and the square root of K reflects the diminishing marginal
growth of capital)
In order to explain long-term growth Solow introduced A, which stands for better ideas
or technological knowledge. This lead to a new production function:
Y = A√K
79
80
”China 2030 Building a modern, harmonious, and creative society” Worldbank report, Final edition 23-03-2013 s. 8-9
Cowen, Tyler & Tabarrok, Alex. ”Modern principles: Macroeconomics”. Worth Publichers, New York, 2010. s. 130
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If K is constant (the Steady state of capital) an increase in A leads to higher productivity and
increasing output. In the graph, there are two production functions with different number of
A. The bigger number of A the bigger output. Hence, Solow emphasizes technological
knowledge to spawn sustainable growth. As long as people are generating better ideas, the
productivity and economy will continue to grow.
Moreover, Solow has explored which factor contributes the most to development –
capital and labour or better ideas? By observing the growth of U.S. Solow estimated that
better ideas contributes to approximately 75 percentage of the improving standard of living.
Other economists have agreed on the importance of ideas and technological progress for the
human well-being. 81
When it comes to China, the slowing economy last years reflects the fact that China’s
catching up strategy is no longer profitable. Hence, the Chinese economy is aiming for cutting
edge, which underlines the importance of innovation and creativity.
The Solow model proves the fact that better ideas can keep the economy growing in the long
run. Imagine that we begin with A = ideas = 1. The economy is in the steady state with output
= 15 at the point a’. By introducing better ideas A increases to A = 1.5 lift the output from 15
at point a’ to 22.5 at point b’. The greater output leads to higher investments, moving from
point a to point b. Since investment is above the depreciation line, capital begins to
accumulate. Capital accumulation continues until the investment is once again equal to
depreciation at point c, which implies an output of 33.75 at point c’. Hence, better ideas and
innovative technology are the keys to long-term economic growth. 82
81
82
Cowen, Tyler & Tabarrok, Alex. ”Modern principles: Macroeconomics”. Worth Publichers, New York, 2010. s. 123
Ibid s. 129
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5.6 What creates an innovative, creative society?
By the Solow model explanation it stands clear – it is time for China to cut the edge. This
strategy point out four essential factors:

Profit-seeking firms

Well functioning institutions

Support by the Government

Expanding market and increasing demand for new products
In order to increase output by better ideas and improved technology, the companies must have
incentives to invest in research and development (R&D). Private companies see R&D as a
profit generating activity framed by costs and uncertainty, which underlines the importance of
well functioning institutions. The key institutions for a successful innovative business
environment are property rights, an honest government, political stability, a reliable legal
system, and competitive globalized market. A diverse and open business culture is essential to
spur innovation and creativity among individuals. Innovators need access to copyright and
patents, high-quality education and financial support to be able to realize ideas successfully.
Without intellectual property rights, such as patents, imitators can steel profit from innovators
by copying new and innovative ideas. Thus, lack of patents deters the incentive to invest on
R&D and innovate new products.83
Due to social spillovers, the whole society can benefit from new ideas. This put a
pressure on the role of government, which must encourage innovators and their important
contribution to the society. Some measures to promote innovation are subsidised activity or a
tax break to R&D expenditures. The government should also provide subsidies to universities,
in particular to those, which generate innovations and create scientists and engineers. In the
U.S. 1.3 million scientists are trained in government-subsidized universities. If the whole
world had provided the same amount support to R&D, the number scientists and engineers
would increase by five times. 84
Indeed the number of better ideas will continue growing in the future as the world
becomes richer and institutions improve. The expanding middle class and increasing global
demand spur incentives for innovation. Moreover, the movement towards property rights,
83
84
Cowen, Tyler & Tabarrok, Alex. ”Modern principles: Macroeconomics”. Worth Publichers, New York, 2010. s. 130-132
Ibid s.132-137
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honest governments, political stability, and a dependable legal system will improve the
innovative environment.85
5.7 Can China build a technological innovative society?
According to Worldbank, China has an opportunity to create a technological society.
The growing middle and affluent classes increase the domestic demand for income-elastic
products, such as leisure activities, high technologic products, and better health and education
services, is expected to grow. Combined with similar developments of other emerging
markets, it creates a profitable platform for Chinese enterprises. Higher demand enables larger
production and economies of scale, which spur innovation and technological improvements.86
Indeed, some urban cities have already developed some recognized knowledge and innovation
centers such as engineering services for Shanghai, logistics and business services for
Shenzhen, information technology and software for Beijing. According to Beardson, the
government undertakes innovation with determination – “Beijing sees innovation as the key,
and seeks to raise research spending and increase the number of patents, scientific citations,
etc/…/The thinking is that China wants to move away from the embarrassing situation of
having to export 800 millions shirts to pay for one imported airplane”.87
Since the economic reforms in 1978, China has gradually improved its technological frontier,
which has created high technological capacity. In combination with China’s high saving rate
the situation permit an increasing capital stock, which facilitates for future technological
catch- up. Through increasing specialization and balanced two-way flow of investment, China
could benefit its technological ability, gain competitiveness on the global market and become
a source of technological innovation.88 This would change the current industrial structure and
create new areas of comparative advantages. If more industries would focus on R&D and
aspire a global breakthrough, an increasing competition would force Chinese enterprises to
put quality before quantity, sustainability before pace, and consumer experience before cheap
prices. However, as explained earlier a successful Business environment requires a long list of
essential conditions to generate a high competition and successful innovative ideas. Last
years, the number of Chinese scientific patents and published papers has accelerated, but
according to Worldbank report “few have commercial relevance and even fewer have
Cowen, Tyler & Tabarrok, Alex. ”Modern principles: Macroeconomics”. Worth Publichers, New York, 2010. s.137
”China 2030 Building a modern, harmonious, and creative society” Worldbank report, Final edition 23-03-2013 s. 10
87
Beardson, Timothy. “Stumbling Giant – the threats to China’s future”. Yale University Press, 2013 s. 80-81
88
”China 2030 Building a modern, harmonious, and creative society” Worldbank report, Final edition 23-03-2013. s.10
85
86
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translated into new products or exports”. 89 One example on lack of innovation is the case of
computer chips. By 2009, China stood for 12% of the world’s computer chips, and was
expected to reach 21% by 2012. However the chips produced, were `two or three years
behind` the international top producers and the high growth was mainly due to large
government support. Furthermore, 41% of the total demand growth since 2003 was driven by
China itself. In other words, positive statistics may not imply international success and high
development.90
According to the organization of Economic cooperation and development, R&D is
defined as: ”creative work undertaken on a systematic basis in order to increase the stock of
knowledge, including knowledge of man, culture, and society, and the use of this stock of
knowledge to devise new applications”. Politicians, academic and businessmen are agreed
that spending on R&D is an economic sign of modernity and dynamism However, R&D
figures are not perfect due to statistical distortions as in the case above.91
Comparing China to the U.S., the most successful innovative in the world, the
conclusion is clear. If China wants to become a worthy rival within the field of innovation and
technology, the country need a greater R&D intensity than its further developed rivals.
However, by 2010, the U.S. spent approximately three times more on R&D than China in
absolute terms, which clearly underlines that China’s global competitiveness may have
improved, but there is a long way left to become a higher-quality, knowledge-based
economy.92 This statement is further supported by the world economic Forum’s global
Competitiveness report (2011-2012), which ranks China as the 26th most competitive
economy in the world (out of 147) by the following motivation: “Factors that have held it
back include: quality of scientific research institutions, managers’ unwillingness to delegate,
availability of financial services, lack of juridical independence, quality of the education
system, the efficacy of corporate boards, low education expenditure, secondary education
enrolment, total tax rate including sales taxes, difficulties of starting a business, tariff barriers,
firing, restriction on capital flows, and the availability of the latest Technologies”.93
Currently China is failing in innovation and faces the risk of being caught up with low
quality exports. The economist Moses Abramovitz points at the need to adapt a decentralized
scientific culture, improved institutional and critical thinking. He has suggested that: ”The
”China 2030 Building a modern, harmonious, and creative society” Worldbank report, Final edition 23-03-2013. s.35
Beardson, Timothy. “Stumbling Giant – the threats to China’s future”. Yale University Press, 2013 s. 80-81
Ibid s. 82
92
Ibid s. 83
93
Ibid s. 84
89
90
91
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differences among countries in productivity levels create a strong potentiality for subsequent
convergence of levels, provided that countries have a social capability adequate to absorb
more advanced technologies”.94. By working against the liberal mind of the Chinese people,
though internet cencure and other state controlling mechanisms, there are doubs if China will
be able to catch up with the innovation speed of the U.S. Indeed, historical evidence support
that the private sector generates better innovation than the R&D centers undertaken by the
Government, and the economist Tomithy Beardson highlights following: ”bureaucrats cannot
guess better than the myriad interactions between producers and consumers”.95 Hence, the
future success of innovation lies in the hand of the population.
A rebalancing process of the economy implies new export strategy driven by innovation
and quality instead of quantity and pace. But in the same time, the condition for this strategy
to succeed, institutions need to improve be a rebalancing of the economy. Something, which
deters both changes, is current Governance, which must decrease its communism controlling
mechanisms and provide sufficient support for future innovator and entrepreneurs. The future
innovation can grow from below but should be encouraged by well-functioning institutions
and a more commercialized business environment, free of inquiry, diversity, challenge and
debate. To make tis possible, the government should begin to loosen the reins and be able to
encourage curious minds without the fear of loosing stability. As Beardson claims: “If critical
thinking and social stability are seen as opposites in a zero-sum game, China will be the
loser”.96 In other words, by an open mind and determinacy, China can create an innovative
platform, increased global competitiveness and a rising power in the future.
6. Supportive reforms
6.1 What is the role of policy?
China’s economy will continue growing even though it is expected to slow. According to
ECB this will ensure social prosperity to a sufficient extent, which may question the need for
urgent rebalancing policies. Moreover, the economic rebalancing is expected to arise
“naturally”, i.e. no matter of the rebalancing policies. Historical experience suggests that
when economic growth stabilizes from a high “catching-up” growth, the economy tends to
rebalance as a consequence. This “natural” process of economic development is supported by
94
95
96
Beardson, Timothy. “Stumbling Giant – the threats to China’s future”. Yale University Press, 2013 s.113
Ibid s. 114
Ibid s. 114
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the economic development of Japan, Korea and Taiwan. 97 But if the economic rebalancing
partly appears “naturally”, what is the role of rebalancing policies?
Evidence proves that economic imbalances in the global economy, is the major reason
for the still unsolved global financial and economic crisis. Moreover, if proper policies do not
complement the “natural” market forces it tends to end up in inadequate economic
development, both domestically and globally. Thereby, China’s imbalances must be met by a
comprehensive set of domestic reforms to prevent an economic stagnation and secure
sustainable economic growth. To permit a transition a modernized society the Government
must embrace measures that enhance competition in domestic sectors, eliminate financial
repression and promote advanced education.98
China’s leadership is well aware of the limitations of the producer-biased and export-led
model. In the face of the two new strategies – to create a more dynamic domestic economy
and a to develop a high-quality, innovative, export model – the government has presented two
comprehensive reformation programs: First, the Five-years plan in December 2011, and,
second the Third plenum in November 2013.
6.2 The Five-years plan
The Five-years plan presents four major sections:
1. The expansion of consumption
2. The improvement of industrial competitiveness
3. Regional development centring on multiple urban areas
4. The promotions of two-way external economic relations – in relation to China’s ability
to reconcile the shift to a new development model with continued growth
(1) Expansion of Consumption
The 12th Five-Year Plan lists two approaches to the expansion of consumption: first, to
accelerate growth of personal incomes, and second, to improve the consumption expectations
of residents.
In order to raise incomes and increase consumption, the section presented three major
focuses – (1) the expansion of employment opportunities, (2) the reduction of the tax burden
for low- and middle-income people, and (3) increases in minimum wage levels and implement
wage guidelines and collective wage negotiations.
97
98
Dorrucci, Ettore Pula, Gabor & Santábara, Daniel. ”China’s economic growth and rebalancing”. ECB, Report 2013 s .48
Ibid s. 49
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In order to expand employment, the priority targets are university graduates, workers
transferring from the agricultural sector, and urban workers who have been unable to find
jobs. Without improving conditions among these social groups, the risk political
dissatisfaction and social unrest is a threat to China’s development.
To improve the consumption expectations of residents measures include (1) the
provision of full coverage under the new pension scheme in rural areas, (2) the efficient
administration of the pension portability system for workers who relocate within urban areas,
and (3) appropriate increase in the minimum livelihood guarantee level.
The measures described above are reflecting the fact that the Government intend to raise
living standards, improve social security systems and eliminate uncertainty about the future. 99
(2) Strengthening Industrial Competitiveness
The second section handles the strategy of improving the industrial competitiveness. The
government focus on reforms within agriculture and the service industry and presented two
major strategies, first, to raise the level of science and technology and second, to increase the
recruitments of qualified labour.
Regarding the manufacturing sector, the government wants to decrease its share of the
economic growth. According to the Vice Premier Li Keqiang, the new strategy will focus on
the development of the emerging industries in order to raise global-scale competition. The
Government will use new promotion strategy with the catchphrase “from big to strong”,
which shift the previous industrial focus from quantity to quality.
Further, the presented reforms emphasize rural modernization, product and brand
development, total factor efficiency and improved production techniques. They also enhance
development of small and medium enterprises through tax incentives and facilitated access to
financing. This is expected to strengthen the industrial competitiveness and expand
employment opportunities in China.
Lastly, this section underlines the importance of environmental protection and
conservation of resources. Wasteful use of the environment is an alarming growth-limiting
factor. An environment friendly approach is essential for social stability and environmental
protection.100
(3) Regional Development Centering on Multiple Urban Areas
99
Sano, Junya. ”Key targets in the 12th Fiver-Year Plan and Policies for their Realization” Pacific Business and Industries, Vol. XI, 2011
Li, Guangyu & Woetzel, Jonathan ”What China’s five-year plan means for business” McKinsey Insights & Publications (2011)
100
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This section emphasizes the importance of urbanization. This is due to the fact that 1-point
increase in the urban population causes a 1.2-point rise in personal consumption demand. And
as increased consumption would stimulate the domestic economy, the urban development
highly prioritised and considered important for a successful modernization of China. One of
the key goals of the 12th Five- Year Plan is that the endorsement of urbanization will exceed
the percentages of the rural population before the end of 2015. 101
Regarding the regional development, Government intend to split China into four
different zones. Each regional zone will be provided more detailed guidelines concerning
promotion for urbanization and job creation strategy. Moreover, the cities will be divided into
mega-cities, large-medium cities and medium-small cities and the government will
particularly promote urbanization from rural areas into medium-small cities, while limiting
the size of mega-cities. The government will encourage the bigger city to limit expansion of
mega-cities in order to prevent social disruption, slump and growing unemployment in the
biggest cities. 102
(4) Promoting Two-Way External Economic Relations
The external economic policies support the fact that China aims to balance the export driven
model and attraction foreign capital. The new strategy intends an equal focus on exports,
imports, the attraction of foreign capital and outward investment and includes three major
objectives, (1), to adopt a two-way approach to trade and foreign direct investment, (2), to
improve technology levels and the service sector to enhance qualitative rather than
quantitative export and (3), to increase the amount of imports in order to optimize the trade
balance, stimulate domestic consumption and alleviate future trade friction.
Considering direct investment, the Government emphasize the competitiveness of
domestic industries, and suggests a comprehensive support for global expansion by
businesses. The policies mainly encourage investment in advanced manufacturing, energy
conservation and environmental protection, and establishment of R&D centres by foreign
companies.
By the end of the 12th Five-Year Plan the Chinese government states that it will
encourage development of its own major multinationals and financial institutions, and limit
support to local companies.103
Sano, Junya. ”Key targets in the 12th Fiver-Year Plan and Policies for their Realization” Pacific Business and Industries, Vol. XI, 2011
Ibid
103
Ibin
101
102
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6.3 The Third Plenum
At The Third Plenum, the government prepared for a reformation program that will be
implemented by the end of 2020. The reformation package was positively met by the out side
world and economists, and has been compared to the one implemented in 1978. A part from
the scope of the package the strategy seem to be gradual implementation, hence step by step,
which was the successful strategy in 1978. Hence there is no expectation of an Economic
Revolution coming years but decisively, the reforms presented requires a total restructuring of
the Chinese economy in the long run.104 According to Kristina Sandclef the most important
reforms are:
Private sector: abolishing of the bureaucratic and inefficient administration in order to
encourage innovation and entrepreneurship. Hence, the new conditions for private firms (in
particular small and medium size-enterprises) will be less restricted by poor financial access
and state control.
Tax reforms: The government will increase its responsibility for local investments in order to
prevent inefficient resource allocation and improve urban development. Two major reforms
have been presented: first, an increasing VAT in some sectors and second, a step-by-step
implementation of a property tax.
Financial reforms: A liberalization of the interest rate.
The hukou-system: the abolishing of the hukou-system will become one of the driving forces
for continuing urbanization. This will mainly benefit the people from the rural areas migrating
to smaller urban cities.
Land reform: the discussion has been circling around weather there should be formal
property rights to the rural areas. However, it is till uncertain of how comprehensive this
section will be.
Price reforms: a number of markets will become free of price regulations. Instead the price
will be subject to supply and demand, which will increase the competition, improve efficiency
and decrease the gap between the state-own and private companies.
State own sector: The state own enterprises will pay higher taxes. By 2020 the goal is that
the SOE’s are paying 30% of it’s profits to the government and the expansion of a social
security system. The new tax-system will be implemented gradually, and is a necessary move
towards a more balanced economy, less dominated by SOE’s.
104
Sandclef, Kristina ”Ingen chockterapi väntar Kina” East capital publications, 11-11-2013
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Further liberalization: the economy will open up for more free market zones. However the
report lack information about how these zones will function in practice. 105
6.4 Comments about the Reformation programs
The reformation programs represent promising measures to rebalance the economy of China.
If the implementation succeeds the conditions could improve at various levels – social,
economic, environmental and global. The Chinese population would benefit from improved
social welfare, higher incomes and less the environmental depletion. Further the push toward
a more market determined economy and fewer advantages for the state-owned sector would
create better conditions for consumers and private enterprises. Overall, the Government’s
reformation programs reflect a new attitude among the policymakers. According to Kristina
Sandclef, their massive extent is in harmony with the World Bank report about how China can
manage to build a modern, harmonious and creative society. The worldbank’s presented
reforms to meet the current trends – challenges, opportunities and threats, which in fact are
very similar to the reforms presented by the government. However, according to Kristina
Sandclef there are two major concerns that could hold back the reformation process: the time
perspective and the political sphere and special interests.106
The reforms need to be implemented soon to have an effectual impact. The
macroeconomic and structural policies have a gradual impact on the economy – they need
time to operate. Moreover, it is difficult to foresee the impact of decelerating growth.
Concealed imbalances may appear stronger than expected and lead to a rapid and painful
market regulation. Policy makers should act pre-emptively and defeat imbalances before the
imbalances cause an economic stagnation. A slow and gradual implementation pace may be
beneficial in the short-term advantages but imply longer-term costs due to the declining
growth factors, and an inadequate reformative impact.107 The reason for the slow
implementation process is the tight connection between economic and political interests.108
The new economic model emphasizing quality, competition and decreasing export will
require stricter conditions for the privileged sectors and has thereby met resistance from
SOEs, financial institutes and the macroeconomic policy management.109 The exchange rate
policies have met the highest opposition. An appreciation of the exchange rate is well
Sandclef, Kristina ”Ingen chockterapi väntar Kina” East capital publications, 11-11-2013
Intervju, Kristina Sandclef, 14-01-2014
Dorrucci, Ettore Pula, Gabor & Santábara, Daniel. ”China’s economic growth and rebalancing”. ECB, Report 2013 s. 50
108
Ibid s. 49-50
109
Ibid s. 49
105
106
107
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anticipated among a global audience, but would imply a lower income for many of the
authorities in China.
In addition to the lack of time schedule, the reformation programs miss political
reforms. In order to push forward the modernization process in China, the number of
innovators, entrepreneurs and consumers must increase. This would happens naturally when
markets are liberalized and the level of individual freedom increased among the population.
However, considering the history and the ideological constraint, is the Government ready to
decrease the number of controlling and discriminating mechanisms in the Chinese society?
Thus, the reformation programs may seem like a clear solution to an international audience
but as Beardson claims: “they must be viewed in the context of a government, which is driven
by the desire to stay in power and yet has a sense of fragility”.110
7. Which are the main challenges of China?
During the 18th National congress 2012 the policymakers promised to double GDP and per
capita income by 2020. However, the Chinese economy is hit by threats and challenges. The
new strategies highlighting increased consumption and technological progress require
efficient urbanization growth, decreased inequality, redistribution of the national income,
rebalancing export model and less “decisive” role of the government. Moreover, a sustainable
growth requires well preparation for challenging domestic and global trends: environment
depletion, demographic change, political instability and social unrest to mention some. In
order to find out if China is mature for a third transition, the current trends and challenges
must be explored.
7.1 Expected trends
A demographic change the coming decades implies an older population and a twice as big old
age dependency ratio in China. A falling population implies a limited window of opportunity
and according to Beardson, China has twenty years to make it’s economic breakthrough,
otherwise the country faces a risk of stagnation.111 The current demographic change is out of
control of the government’s influence. Last year, the government discussed abolishing of the
110
111
Beardson, Timothy. “Stumbling Giant – the threats to China’s future”. Yale University Press, 2013 s.398
Ibid s.398
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one-child policy but is will take long time before the labour force starts increasing again.112
Nevertheless, a demographic change is not only associated with threat. According to Wang
the dependency ratio (i.e. the ratio of people of non-working age to those of working age) has
declined from a level of around 80 children per 100 workers in the mid-1970s to below 40
today. Hence, the oldest and the youngest members of the population, which are not able to
save, but to consume –– is expected to increase relative the previous demographic trends in
China.113 Moreover increasing wages will cause a growing middle class, which will put an
increasing pressure on the government. The middle class Chinese demands transparent
governance and a better chance to be involved in the politics and influence. Hence, if these
demands are met by improved governance it could bring a positive effect in terms of
increased mutual trust between government and the population.114
Another positive trend is the fact that the inequality is expected to stabilize. This
development is driven by three major factors: first the gap between the developed and
underdeveloped regions in China will narrow as industries is expected to reallocate to the
underdeveloped part of China where they can benefit lower wages and price of land. Second,
rural and urban income will become more equal because of increased productivity and rising
wages on the countryside. According to the European Central Bank, the urban-rural income
ratio is expected to fall from 3.2:1 in 2010 to 2.4:1 in 2030.115 Third, the incentives for rural
workers to shift to manufacturing sector will decline because of more equal wages, which
implies a slowing rate of rural-urban migration. However, even if the migration rate is
expected to fall, the urban population is estimated to grow from about one- half to near twothirds in 2030.116 The urbanization is one of China’s major challenges and the main engine for
increased consumption growth. Economic data estimates that 10% increase in a Province
urbanisation lead to a per capital consumption increase by 30%.117 Moreover, the economist
Yichuan Wang, claims that an efficient urbanization and increased urban population is
determinant for improving the public services. In his article for Quartx he mentions:
“Empirical research in China has established that large population sizes are necessary to
support service industries” 118 However, much depends on the central and local governments
ability to invest and allocate the resources efficiently. How should China attack the growing
urbanization?
White, Hillary ”David Attenborough praises China’s One Child Policy” Life Site News, 09-11-2013
Feng, Wang. ”China’s Population Destiny: The Looming Crisis”. Brooklings research. 09-2010
114
Dorrucci, Ettore Pula, Gabor & Santábara, Daniel. ”China’s economic growth and rebalancing”. ECB, Report 2013. s. 9
115
”China 2030 Building a modern, harmonious, and creative society” Worldbank report, Final edition 23-03-2013
116
Ibid s.277
117
Yang, Yishuan. ”China can boost consumption by moving children and elderly into the city”. Quartz, 09-10-2013
118
Ibid
112
113
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7.2 “Smart urbanization”
Meeting China’s urbanization challenge implies an interaction between economic and social
reforms, fiscal strength and global integration. The expansion of the cities of China must be
healthy and sustainable in order to minimize inequality and waste of resources. In 1978, less
than 20% of China’s population lived in cities; by 2009, the urban population is close to 50%;
and by 2030, the share is expected to grow to two-thirds. This estimates around 13 millions
more urbanities each year. 119
Significantly, the rapid urbanization benefits the inland of China, which are catching up
with the coastal cities. The 20 of China’s fastest growing cities, located in the inland regions,
will experience improving conditions with rising per capita incomes, low-cost transport links,
communications facilities and social capital accumulation. The coming decades, most of the
urban growth will result from the expansion of existing cities. Economists agree that cities are
strong engines of growth as they permit access to markets, economies of scale and technology
spillovers. The higher population densities the better, as it facilitates profitable and costeffective investments in private and public sector and creates better conditions for innovation.
Hence, the urbanization needs to be “smart” and supported by wide range structural
reforms. It involves an improved public services sector, providing support for healthcare,
education, transports, water and energy, no matter if a family is a registered urban hourehold
or not. Furthermore, fiscal politics need to improve, pointing at higher requirements on the
local governments and a decreasing inequality in the amount of resources between cities. This
process would require structural reforms within the tax sharing and transfer payments with the
central government and new tax instruments, such as a land and property tax. This is
necessary as the strength of the tax system decides weather the local governments can provide
sufficient financial support to develop the public services. Additionally, in absence of a
proper tax instruments, land sales will remain the major source of income among local
government and lead to increasing arable land, which tends to increase the size of the cities
and cause urban slumps with negative effects on social development120
Another important aspect of the “smart urbanization” –strategy is the population density
of the cities. Increased density is proven to minimize cost of public services, improve energy
and transport efficiency, and reduce the loss of cultivable land. Geographic expansion is for
example one consequence of blurry land ownership can and has lead to huge areas of
119
120
”China 2030 Building a modern, harmonious, and creative society” Worldbank report, Final edition 23-03-2013. s. 23
Ibid s. 23
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underutilized land in the centre of Chinese cities, which brings urban inefficiencies. Instead
population density should be increased and accompanied by increased intra- and intercity
connectivity. Increasing connectivity between cities would imply increased international
competitiveness as it reduces economic distances, supports greater scale economies and
provide conditions for more advanced specialization. Increasing connectivity within the cities
is boosts city efficiency and reduces carbon footprint through alternative options to private
automobiles. To improve the national infrastructure networks the state own enterprises
producing power grid, railways, and telecommunications, will be financially supported by the
government and hopefully benefit within scale and procurement power. However, because of
the lack of competition the domestic infrastructure risk to develop below global standards of
quality and cost, which would imply harmful effects for China in the long run. In other words,
as most of the modernization projects of China, the power lies in the will of the government.
A third point is the importance of urban planning. “Urban areas that mix residential,
recreational, shopping, and business facilities tend to develop more vibrant communities, have
a smaller ecological footprint, enjoy lower crime rates, and generally improve the quality of
life”.121 Hence, a city needs to match the changing needs of the citizens’ lifestyles. This
implies constant public and private investments, a non-discriminating fiscal strategy and a
proper role of the government. Good urban governance must act in the interest of the citizen
and meet the needs of private enterprises and civil society organizations. The local
governments should encourage citizen participation in land use planning and offer citizen
reports and surveys over public satisfaction and dissatisfaction with the quality of public
services. It should also support and encourage the participation of the citizens and initiatives
such as voluntary organizations, health and education services etc. Economists agree that
substantial changes need to be made in the local governments practice and attitude.122 The
role of local governments should be as supervisor and coordinator in accordance with the
central government’s guidelines. Their reformation programs should also be based on a new
development index including social and environmental measures, instead of only indicators of
economic growth. This would be in line with the expanding middle-class and their aspiration
to higher quality of life.123
A last recommendation for “smart urbanization” is to increase the government’s efforts
to encourage technological progress and innovation creating knowledge centers. The
government has already identified 20 potential cities that will be endorsed with “sound
”China 2030 Building a modern, harmonious, and creative society” Worldbank report, Final edition 23-03-2013 s. 24
Ibid
123
Ibid
121
122
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infrastructure, modern transport and telecommunication facilities, local universities and
research centers, and a critical mass of skilled labour”.124 The remaining cities, which does not
reach the standards of becoming knowledge and leading technology R&D centers, should
provide space for manufacturing and service industries, which are expected to reallocate in
order to benefit cheaper land and labour.125
Regarding the fate of the urban cities in China, one of China’s most successful cities,
Foshan, has become an inspiring source. Foshan is a city in the Southern province of
Guangdong that has become the “emerging economic frontier” in China. By successful
establishment of industrial clusters, specialized at furniture, textiles, appliances, ceramics and
the equipment necessary to the production, Foshan has created the worlds biggest furniture
market and generated some of China’s most outstanding private firms. Current its successful
growth pattern is under investigation by Fung Global institute.126
In fact, Foshan has already implemented many of those reforms discussed today by the
government. Since the 1990s, the private sector has growth due to the fact that the most
profitable government-supported enterprises have been sold to their managers, workers and
outside investors. While the profit-making firms became private owned, the loss-making
governmental enterprises were consolidated to bigger more profitable ones. This development
is in line with one of the major objectives of the government today – to make the market have
a more “decisive” role in the allocation of resources. Last year, the private sector in Foshan
has contributed to a twice as big growth as the remaining state-owned firms. Moreover, the
private capital has contributed to the major development of the city’s public infrastructure
being involved in 500 infrastructure projects, including power generation, water plants and
rubbish-incineration plants.127
One explanation to the experimentation propensity is the administrative structure. Until
2002, Foshan involved two independent cities Shunde and Nanhai, which had separate
decision-making processes. According to Mayor Liu, this more local structure decreased the
distance between the local government and the citizens, which increased the sense of
responsibility. However, even though the pattern of Foshan provides a blueprint for
other cities, it is not a guarantee for success. First, the rapid growth and industry
clusters has been harmful for the environment. Since 2003, the city has introduced
regulations on environmental depletion but still the conditions are severe. As Mr Liu
”China 2030 Building a modern, harmonious, and creative society” Worldbank report, Final edition 23-03-2013 s. 24
Ibin
126
The Economist. ”New frontiers”. 11-01-2014
127
The Economist. ”New frontiers”. 11-01-2014
124
125
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Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
claimed: “We understand that our poor environment does not attract talented
people”.128 Without improved conditions, Foshan faces a drag on future growth. A
second aspect, points at the fact that all cities cannot benefit the same pattern of
Foshan. An increasing amount industry clusters would lead to higher competition,
meaning that only a few cities would be able to develop out of it. As the economist
explains it: “China is dotted with ambitious local governments keen to build hubs of
high-tech firms and services. Not all of them can succeed”.129
7.3 How to overcome Economic slowdowns?
The transition from a middle- income to a high-income society will be challenging as much
depends on the uncertain global environment. Current phase of the global economy is
characterized by high volatility, increasing uncertainty and after-effects of the global financial
crises. Many current trends may support a positive development in China, but a potential
economic slowdown is a threat to the aspired modernization. Economists are warning about
unrevealed economic distortions under the veil of the rapid growth, which could become
certain in the face of an economic slowdown. Many international articles have discussed the
warning signs of “bad loans” and the booming real estate prices and in worst-case scenario,
these distortions may even cause a fiscal and financial crisis and
The government could respond differently to a slowdown depending on its causes.
Regarding a macroeconomic shock, like a sudden fall in real estate prices or a drop in global
market demand, the situation would require short-term measures and rapid financial support.
Positively, the current strong fiscal and debt levels permit China to remain relatively strong
throughout a macroeconomic shock, except for potential increase of social unrest as economic
interests tend to overshadow domestic issues during crisis.
A more concerning cause of slowdown would be the so-called middle- income trap. To
reach middle-income standards low-incomes countries adopt labour-intensive, low-cost
production to compete in the global markets. Labour shift from agriculture to manufacturing
sector, and higher production, due to increasing export and the Solow-explained “catch-up”effect, will eventually lead to middle-income status. But thereafter, the comparative
advantages (low-cost labour and easy technology adoption) are no longer enough to develop
the country further. Because of shrinking rural labour force, rising wages and exhausted
technology convergence, productivity and export-driven growth declines. In the aspiration for
128
129
Ibid
Ibid
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Bachelor Essay, Autumn 2013
Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
a high-income status, the country must adopt new sources of growth, otherwise the it will
become trapped in a powerless situation with decelerating growth and poor development.
Historically, the fate of the middle-income trap is widespread –13 out of 101 middleincome economies managed to became high-income countries by 2008. Economists like
Michael Pettis and Barry Eichengreen, have warned China’s economy for similarities with the
Japanese economic bubble during1980s, which trapped the economy in a long-term
stagnation.130 However, by successful and efficient implementation of new reforms, China
could spur the new growth engines and manage to avoid the middle-income trap and future
stagnation.
7.4 Social tensions
The risk of lower growth rates is intensified by China’s relatively high income and asset
inequality. Due to the hukou-registrations and weak employment institutions, millions of
Chinese are caught in low-income jobs and the implicit household income tax and price
distortions, benefit the state own enterprises but harm private households. Combined, these
factors fuel the distortions of the national income division – a decreasing share of wages and
household income and a growing share of capital and Government profit. The inequitable
structures if the Chinese society may imply increasing social tension and political friction.
According to World Bank, the social instability is expected to arise from two directions. The
rural population are becoming more hostile due to the discriminative national income division
and the “opportunity gap” between the rural and urban regions. As earlier mentioned, public
protests outside the cities have increased, and the influence of extremist social groups is
growing. 131 Second, experiences of other countries tells that a growing middle class and
higher education levels, will increase the demand for better social governance and more
transparency in public policy implementation. Unmet, the rising dissatisfaction will threat the
future stability and make it difficult for the Government to unify the country and manage to
rebalance the economic growth.
7.5 The role of the Government
The Chinese government is often criticized for it’s undemocratic political system
framed by inflexibility and political tensions. Since 1978, there have been increasing
contradictions within the political sphere, especially between the richer coastal provinces and
130
131
”Världspolitikens dagsfrågar – Kina” The Swedish Institute of International Affairs, 2013 s. 62
”Världspolitikens dagsfrågar – Kina” The Swedish Institute of International Affairs, 2013 s. 62
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Bachelor Essay, Autumn 2013
Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
poorer inland regions. They do not share the same objectives and the access to resources is
diverse. In the richer regions, governors keep their eyes on growth and maximizing profits of
SOE’s, while the inland authorities are facing growing unemployment, poverty and political
resistance. As discussed above, the central government should distribute the resources more
equally among the local governments and thereby permit for stronger local governance.
However, an increased responsibility among the local governments underlines the importance
of stricter control within the political sphere. In contrast, to the successful case of the
governance of Foshan, other cities are facing high corruption and inefficient allocations of
resources leading to widespread absence of transparency and institutional trust.132 Political
Leaders are often involved in the most powerful SOEs and estimated to run 90 percent of the
biggest companies. A growing number reports regarding lush salaries, generous perks, and
corruption has reached the population, which calls it qianguize – ‘‘hidden rules of the
game’’.133 Hence, on could claim that “China has a power-based economy, not a market
one.”134 The question is if the political instability will deter the rebalancing of the economic
growth? Beardson believe that the current fragile political system combined with educational
and cultural restrictions will deter consumer expenditure and innovative growth. Even though
the Chinese population could manage to push the modernization process forward, the strong
ties between the political and economical interests may risk to hold back it back. Much is
depending on the current government’s implementation process and its strength to ignore
short-term pleasures for long-term sustainable growth.
Conclusion
The socioeconomic environment has changed drastically since the economic boom in China.
The new environment puts a pressure on a rebalanced economic growth and the Chinese
Government. Global institutions and economists all over the world have emphasized two
major growth factors: domestic consumption and innovation. The natural development of the
Chinese economy combined with the presented comprehensive reformation programs are
expected to improve the conditions for innovation and consumption growth. Hence, the dream
of modernization and high-income status appears to be reachable. Historically, China has
Redding, Gordon & Witt, A. Michael “The futue of Chinese capitalism”. Oxford University press, 06-12-2007,
133
Faure, Guy, Oliver & Fang, Tony ”Changing Chinese values: Keeping up with the paradoxes”. International Business Review, 2008
134
Roberts, Dexter ”China's State Enterprises Have to Pay Up” Bloomberg BusinessWeak 05-17-2012
132
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Bachelor Essay, Autumn 2013
Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
managed a transformation within three decades. Evidence shows that it is easier to manage a
transformation from a low-income county to a middle-income one. This is partly explained by
the Solow model, which points at the catching –up phase: rapid growth due to that high
investment exceeds the capital depreciation. However, a catch-up – phase does not permit a
long-term sustainable growth towards a high-income status. Instead, a further development
requires better innovative ideas and speeding up the production capacity. This is proved
difficult as many middle-income countries are failing in innovation and ending up in
stagnation because of the inefficiently high state-control and unequal distribution of the
national income. Will this become the fate of China?
The Chinese Government has not ignored the fates of the middle-income trapped countries.
The presented strategies are detailed and could support a modernization process in China, if
that is what China wants. The last reformation programs, the 12th fiver year plan and the Third
Plenum, support the fact that the Government will undertake the rebalancing reforms with
determination.
However the lack of reforms of the political structure may result in a slow
implementation process. Corruption is widespread, both on central and local level. Moreover,
traditional measures to control the population still remain and the market economy is far from
complete. State-owned enterprises are provided special treatment by financial and political
systems while the market conditions for the foreign and private enterprises still are
discriminative. In an economic development point of view, this is irrational considering the
fact that the private sector is proved to be more profitable, innovative and beneficial for the
consumer.
Additionally, the social environment calls for improvements concerning social safety,
healthcare and education. Improved welfare would decrease the concerns among the private
households, which still deter consumption growth in China. It has become clear that culture is
no longer the major reason for the low consumption growth, but the lack of fundamental
mechanisms supporting growing optimism and increasing incomes among Chinese
households. Perhaps the government is anxious to loosen the grip of such mechanisms due to
the fear of facing an increasing domestic demand, since this demand would not only include
the desire for income elastic products but also for more transparent governance, better quality
of life, and higher individual freedom. However, an increased demand is necessary in order to
release the “caged tiger” and enable a modernization process in China.
Another obstacle within the political area is the perspective of time. If the Chinese
government is passive or acts slowly towards a reformation, the economists agree: the
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Bachelor Essay, Autumn 2013
Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
probability for a positive outcome decreases. In the case of an economic slowdown, hidden
and observable imbalances could grow and require short term- economic measures and
thereby hinder the implementation of necessary reforms. But even with a continuing
economic growth, there are uncertainties whether the Chinese government will respect the
importance of urgency. If not, what could be the reason? Specific interests among authorities
at different levels? An underestimation of the need of a transformation? Fear of loosing
control? Or lack of trust in the Chinese people? Hence, the uncertainties concerning the
underlying objectives of the Government will still remain.
The communist ideology has caused global trade frictions, discriminated markets,
inefficient resource allocation and a gap in the Chinese society. However it was the
Communist party, which managed to transform China. Chow underlined five factors, which
enabled the rapid development – among these, the party’s pragmatic approach and the strong
leadership. Today, the conditions have changed but the same fundamental questions remain:
Which are the core interests? What external mechanisms threaten them? And what can the
leadership do to protect them? During 1978 the core interests were consumer welfare,
globalization, economic growth and political stability. The threat was mainly ideological and
traditional constraint within the communism ideology, which complicated the reformation
process to some extent. However, throughout the economic transformation the strong
leadership kept a determinacy and a pragmatic approach and underlined the importance of
“seeking truth from facts”. Just as the communist party in 1978, the government should not
embellish the current situation, but follow the implementation programs to the letter, present a
relevant time schedule and dare to meet a growing individualism. If the objective really is to
increase consumption and innovation, they must strive for a new climate of mutual trust. The
government must understand that is cheaper to encourage people than to control them. By
providing them more individual space and increasing opportunities to flourish, the capitalism
and modernization process of China will spur from below.
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Bachelor Essay, Autumn 2013
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Mentor: Zouheir El-Sahli
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Mentor: Zouheir El-Sahli
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Bachelor Essay, Autumn 2013
Author: Fanny Nachemson
Mentor: Zouheir El-Sahli
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